Payment options in trade transactions include, for example, letters of credit, pre-payment, sale on open account, documentary collection or draft, and consignment sale. The documentary letter of credit (“Credit”) is a widely used payment instrument in trade transactions, and particularly international trade transactions. A Credit is an undertaking by a person, usually a bank, to pay money upon the presentation of certain documents. It is an arrangement whereby a bank, acting at the request and on the instructions of a customer (“applicant”) or on its own behalf, (i) is to make payment to or to the order of a third party (“beneficiary”), (ii) is to accept and pay bills of exchange (“drafts”) drawn by the beneficiary, (iii) authorizes another bank to effect such payment, to accept and pay such drafts, or (iv) authorizes another bank to negotiate, against the presentation of stipulated documents under the terms of the Credit.
The parties to a Credit are typically comprised of at least an applicant, an issuing bank, and a beneficiary. The applicant is usually a buyer or importer of goods; the beneficiary is usually a seller or exporter of goods; and the issuing bank is usually a bank or other person that undertakes, as previously described, to pay, accept, or negotiate a Credit against a presentation of documents conforming to the stipulated documents under the Credit. A Credit should state precisely the documents against which payment, acceptance or negotiation is to be made. Credits may be revocable or irrevocable, and may be payable immediately (“at sight”) or at a later date (deferred payment, acceptance, or negotiation). Credits are often issued with an expiration date, and documents presented after expiry are usually not honored.
A Credit may authorize another bank, often called a nominated bank, to pay, accept, or negotiate provided that the stipulated documents are presented and that the beneficiary complies with the terms and conditions of the Credit. Credits may be confirmed by another bank, thereby establishing a separate and independent undertaking on the part of the confirming bank to pay, accept, or negotiate against documents which appear on their face to be in conformity with the documents stipulated under the Credit.
Stipulated documents under a Credit typically relate to the transfer of title to goods, and may include at least one of, for example, a bill of lading, a commercial invoice, a draft or bill of exchange, a consular document, an insurance certificate, and/or an inspection certificate. Documents may be electronic records as well as paper records. Payment under a Credit is made upon presentation of stipulated documents, which can be conceptualized as payment upon a constructive delivery of goods rather than on actual physical delivery. In practice, one or more intermediary banks may be involved in a Credit transaction. One such bank, often called an advising bank, may notice or advise the beneficiary of the issuance and terms of the Credit. The same or another intermediary bank may accept drafts and/or documents under the Credit, and forward such drafts and/or documents to the issuing bank or to another bank for payment, acceptance, or negotiation. An intermediary bank authorized to pay, accept, or negotiate is often called a nominated bank. A nominated bank's receipt, examination, and/or forwarding of documents presented under a Credit, however, does not usually make that bank liable to the beneficiary. A nominated bank that pays, accepts, or negotiates a Credit, that is, gives value in good faith for conforming documents presented under a Credit, is sometimes called a paying or negotiating bank and has a claim for reimbursement from the issuing bank despite fraud. Under law and practice, banks receiving drafts and/or documents under a Credit have only a few days to take up (honor) conforming documents or refuse (dishonor) discrepant documents, that is, documents which do not conform to those stipulated in the Credit.
Where multiple intermediary banks handle documents under the Credit, the paying or negotiating bank has a claim for reimbursement from the issuing bank or, where designated in the Credit, the reimbursing bank. The reimbursing bank, where separate from the issuing bank, has a claim for reimbursement from the issuing bank. All such claims for reimbursement are payable upon presentation of conforming documents and compliance with the terms of the Credit. The issuing bank is entitled to payment or reimbursement as provided in the agreement between the issuing bank and the applicant, usually including presentation of conforming documents.
Under the independence principle, the undertakings, obligations, and liabilities between participants in a Credit transaction are separate and independent. That is, the undertakings, obligations, and liabilities between the applicant and the beneficiary are separate from, and not contingent upon or affected by, the validity, binding affect or enforceability of the undertakings, obligations, and liabilities existing between the applicant and the issuing bank, the issuing bank and the beneficiary, the issuing bank and any nominated bank, any nominated bank and the beneficiary, and/or any confirming bank and the beneficiary. The issuing bank's undertaking to pay, accept, or negotiate a Credit is independent of and not subject to claims or defenses by the applicant resulting from its underlying relationship with the beneficiary, and a nominated bank's claim for reimbursement of payments made under a Credit is independent of and not subject to the validity, binding effect, or enforceability of the undertakings between the applicant and the issuing bank or the underlying relationship between the applicant and the beneficiary. Further, under the rule of strict compliance, a beneficiary seeking payment under a Credit must present the exact documents stipulated in the Credit, and the issuing bank must accept only those exact documents.
Because of the potential risk of not receiving reimbursement if a bank pays, accepts, or negotiates a Credit (due to the presented documents subsequently being determined to be discrepant, being presented after the expiry of the Credit, or the insolvency of the participant from whom reimbursement is to be obtained), documents received under a Credit are commonly forwarded by the nominated bank to the issuing bank or any reimbursing bank, by any reimbursing bank to the issuing bank, and ultimately by the issuing bank to the applicant, for examination, acceptance, and payment before the issuing bank or any nominated bank pays, accepts, or negotiates the Credit. This forwarding of documents, sometimes multiplies and may result in a significant delay in payment to the beneficiary. Moreover, each intermediary bank imposes fees associated with its handling of documents, and for payment, acceptance, or negotiation, thereby increasing the costs of the transaction.
FIG. 1 illustrates the flows in a representative transaction for which a Credit is used to facilitate payment. An applicant 10 (usually a buyer or an importer of goods) submits a purchase order 11 to a beneficiary 40 (usually a seller or an exporter of goods). After agreement on the terms of purchase and sale, the applicant 10 makes application 21 to its bank, the issuing bank 20, to open a Credit in favor of the beneficiary 40 for payment under the purchase order 11. The application 21 typically specifies the documents that must be presented by the beneficiary 40 for payment under the Credit.
Upon acceptance of the application 21, the issuing bank 20 issues, or opens, its Credit 31 in favor of the beneficiary 40 and for the account of the applicant 10. The Credit typically includes a face amount in a denominated currency and an expiration date, and includes all instructions to the beneficiary relating to payment, including a description of the stipulated documents which must be presented to obtain payment. Such documents may include a draft drawn on a nominated bank 30 or the issuing bank 20. The Credit may nominate the bank authorized to pay, accept, or negotiate, or may be freely negotiable. Where freely negotiable, the credit may designate a reimbursing bank.
The issuing bank 20 advises the beneficiary 40 of the issuance and terms of the Credit 31, or requests that a bank, namely advising bank 30 having an office where the beneficiary 40 is located, advise 41 the Credit 31. The beneficiary 40 arranges for the shipment of goods 12 under the purchase order 11, and obtains from exporters, freight forwarders, governmental officials, and other persons such documents 42 relating to the goods 12 and their shipment as may be required by the Credit 31. The documents 42 may be tangible records or may be in electronic form.
The beneficiary 40 presents the documents 42 evidencing full compliance with the terms of the Credit 31 to the nominated bank 30. The nominated bank 30 examines the documents 42, and if the documents 42 appear conforming, sends the documents 42 to the issuing bank 20 for review. The issuing bank 20 examines the documents 42, and, if the documents 42 appear conforming, the issuing bank 20 notifies the applicant 10, and may send the documents 42 to the applicant 10 for examination.
The applicant 10 examines the documents 42, and if the documents 42 appear conforming, so notifies the issuing bank 20. The applicant 10 also uses the documents 42 to claim the goods 12. The issuing bank 20 notifies the nominated bank 30 of the issuing bank's 20 acceptance of the documents 42, and authorizes payment, acceptance, or negotiation 43 of the Credit 31. Typically, the issuing bank 20 concurrently obtains payment 23 from the applicant 10, and pays or reimburses 33 the nominated bank 30 for payment, acceptance, or negotiation 43 of the Credit 31. The nominated bank 30 pays, accepts, or negotiates 43 the Credit 31 against the documents 42 upon receipt of authorization from the issuing bank 30 and payment 33.
As illustrated in FIG. 1, each of the undertakings of the applicant 10 and the beneficiary 40, the applicant 10 and the issuing bank 20, the issuing bank 20 and the advising/nominated/negotiating bank 30, and the advising/nominated/negotiating bank 30 and the beneficiary 40 is separate and distinct under the independence principle, and is usually not subject to the validity, binding effect, enforceability, or performance of any other undertaking. Also, the nominated bank has no obligation or liability to the issuing bank to pay, accept, or negotiate the Credit, and except where the nominated bank confirms the Credit, no obligation or liability to the beneficiary to pay, accept, or negotiate the Credit.
Efforts to address issues of cost, certainty, and speed of payment in the processing of Credits and documents presented under Credits have generally focused on online services for the simplification and transmission of Credits and trade documents and electronic payment systems. For example, bolero.net provides a system through which parties can exchange secure trade documents and data via the internet. TradeCard and @GlobalTrade are internet-based systems for completing and financing international trade transactions. SWIFT, an industry-owned cooperative, provides global, secure, standardized messaging services to financial institutions.
Credits are largely governed by national laws. For example, in the U.S., Credits are governed by Art. 5 of the Uniform Commercial Code (“UCC”), as adopted by the various states. Most Credits are also subject to the Uniform Customs and Practice for Documentary Credits, Publication 500 (“UCP”), developed by the International Chamber of Commerce (“ICC”). The UCP is an international body of trade practice, custom, and standards of performance for Credits that is commonly incorporated by agreement of the parties for international and domestic Credits. There are many sources of information concerning law and practice applicable to Credits, including JOHN F. DOLAN, THE LAW OF LETTERS OF CREDIT, COMMERCIAL AND STANDBY CREDITS, REVISED EDITION (1996), and the official commentary to UCC Art. 5. The uniform version of and official commentary to Art. 5, the UCP, and Dolan are incorporated by reference.